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Peoples Energy Corporation (the Company) is solely a holding company and does not engage directly in any business of its own. Income is derived principally from the Company's utility subsidiaries, The Peoples Gas Light and Coke Company (Peoples Gas) and North Shore Gas Company (North Shore Gas). The Company also derives income from its other subsidiaries, Peoples Energy Resources Corp. (Peoples Energy Resources), Peoples Energy Services Corporation (Peoples Energy Services), Peoples Energy Production Company (Peoples Energy Production), Peoples District Energy Corporation (Peoples District Energy), Peoples Energy Ventures, LLC (Peoples Energy Ventures) and Peoples NGV Corp. (Peoples NGV). The Company and its subsidiaries had 2,479 employees at September 30, 2002. (See Note 2 of the Notes to Consolidated Financial Statements.)

The Company was incorporated in 1967 under the Illinois Business Corporation Act and has its principal executive offices at 130 East Randolph Drive, Chicago, Illinois 60601-6207 (Telephone 312-240-4000). Its business activities are segregated into six segments.

The Gas Distribution segment is the Company's core business. Its two regulated utilities (Peoples Gas and North Shore Gas) purchase, store, distribute, sell and transport natural gas to approximately one million customers through a 6,000-mile distribution system serving the City of Chicago and 54 communities in northeastern Illinois. The customer base includes residential, commercial and industrial retail sales and transportation accounts which provides a broad foundation with no reliance on any particular group of customers.

For fiscal 2002 and on September 30, 2002, the Gas Distribution segment accounted for 72.0 percent of operating revenues, 91.9 percent of operating and equity investment income and 86.9 percent of segment capital assets.

Peoples Gas was formed in 1855 and had 2,123 employees at September 30, 2002. It has approximately 850,000 residential, commercial and industrial retail sales and transportation customers within the City of Chicago (City).

North Shore Gas was formed in 1900 and had 217 employees at September 30, 2002. It has approximately 150,000 residential, commercial and industrial retail sales and transportation customers within its service area of approximately 275 square miles, located in northeastern Illinois.

The basic marketing plans of Peoples Gas and North Shore Gas are to maintain their existing shares in traditional market segments, which include space-heating, water heating, clothes drying and cooking. They also seek opportunities emerging from changes in the utility environment and technological equipment advances for new, expanded or current natural gas applications, including cogeneration, prime movers, microturbines, natural gas-fueled vehicles and natural gas air-conditioning. North Shore Gas' service territory has potential for expansion through increasing population density.

Starting in 2002, all customers have the opportunity to choose a gas supplier. The utilities make their income on the transportation of natural gas and continue to transport the gas that customers choose to purchase from a competitor. Competition in varying degrees exists between natural gas and other fuels or forms of energy available to consumers in the Midwest and the utilities' respective service territories. The utilities do have a natural monopoly on the distribution of natural gas within their areas as discussed in the "Importance of Regulatory Environment" section.

Peoples Gas and North Shore Gas have each entered into various long-term and short-term firm gas supply contracts. When used in conjunction with contract peaking and contract storage, Peoples Gas' company-owned storage and the peak-shaving facilities of the utilities, such supply is deemed sufficient to meet current and foreseeable peak and annual market requirements.

Although the Company believes North American gas supply to be sufficient to meet current and prospective United States market demands, it is unable to quantify or otherwise make specific representations regarding national supply availability and the cost of that supply.

The following tabulation shows the expected design peak-day availability of gas in thousands of dekatherms (MDth) during the 2002-2003 heating season for Peoples Gas and North Shore Gas:

Peoples Gas and North Shore Gas forecast maximum peak day demands of 2,381 MDth and 403 MDth, respectively.

The sources of gas supply (including gas transported for customers) in MDth for Peoples Gas and North Shore Gas for the three years ended September 30, 2002, 2001and 2000 were as follows:

Effective April 1, 2002, Occidental Energy Marketing, Inc. acquired from Enron North America Corporation (Enron) gas supply agreements with Peoples Gas and North Shore Gas under which the utilities purchase a substantial amount of their supplies. (See Management's Discussion and Analysis of Results of Operations and Financial Condition (MD&A), Other Matters - Enron Bankruptcy Filing.) The Company believes the utilities have contracted for adequate gas to meet supply needs for fiscal 2003.

Influence of Regulation. Peoples Gas and North Shore Gas are authorized, by statute and/or certificates of public convenience and necessity, to conduct operations in the territories they serve. In addition, these subsidiaries operate under franchises and license agreements granted to them by the municipalities they serve. Peoples Gas holds a perpetual, nonexclusive franchise to serve the City of Chicago. North Shore Gas' franchises with municipalities within its service territory are of various terms and expiration dates.

Absent extraordinary circumstances, potential competitors are barred from constructing competing gas distribution systems in the utility subsidiaries' service territories by a judicial doctrine known as the "first in the field" doctrine. In addition, the high cost of installing duplicate distribution facilities would render the construction of a competing system impractical.

A substantial portion of the gas that Peoples Gas and North Shore Gas deliver to their customers consists of gas that the subsidiaries' customers purchase directly from producers and marketers rather than from the utilities. These direct customer purchases have little effect on net income because the utilities provide transportation service for such gas volumes and recover margins similar to those applicable to conventional gas sales.

A pipeline may seek to provide transportation service directly to end-users. Such direct service by a pipeline to an end-user would bypass the local distributor's service and reduce the distributor's earnings. No Peoples Gas customers have been lost to bypass service; only one end-user in North Shore Gas' service territory is served directly by a pipeline supplier. Both utility subsidiaries have a bypass rate approved by the Illinois Commerce Commission (Commission), which allows the utilities to renegotiate rates with customers that are potential bypass candidates.

Both Federal and State governments have legislation that provides for additional funding for assistance to low-income energy users, including customers of the Company's utility subsidiaries. The state legislation creates a fund, financed by charges to electric and gas customers of public utilities, participating municipal utilities and electric co-ops, which supplements currently available federal energy assistance.

Impact on Sales and Rates. Peoples Gas and North Shore Gas sell natural gas having an average heating value of approximately 1,000 Btus per cubic foot.* Sales are made and service rendered by Peoples Gas and North Shore Gas pursuant to rate schedules on file with the Commission containing various service classifications largely reflecting customers' different uses and levels of consumption. The Gas Charge is determined in accordance with the provisions in Rider 2, Gas Charge, to recover the costs incurred by Peoples Gas and North Shore Gas to purchase, transport and store gas supplies. The level of the Gas Charge under both subsidiaries' rate schedules is adjusted monthly to reflect increases or decreases in natural gas supplier charges, gains, losses and costs incurred under its hedging program, purchased storage service costs, transportation charges and liquefied petroleum gas costs. In addition, under the tariffs of Peoples Gas and North Shore Gas, the difference for any month between cos ts recoverable through the Gas Charge and revenues billed to customers under the Gas Charge is refundable to or recoverable from customers. (See Note 1L of the Notes to Consolidated Financial Statements.)

Legislation and Regulation at State Level. Peoples Gas and North Shore Gas are subject to the jurisdiction of and regulation by the Commission, which has general supervisory and regulatory powers over practically all phases of the public utility business in Illinois. These include rates and charges, issuance of securities, services and facilities, systems of accounts, investments, safety standards, transactions with affiliated interests and other matters.

Legislation and Regulation at Federal Level. The Company is a holding company as defined in the Public Utility Holding Company Act of 1935 (1935 Act). By Order entered on December 6, 1968 (Holding Company Act Release No. 16233), the Securities and Exchange Commission (SEC), pursuant to Section 3(a)(1) of the 1935 Act, exempted the Company and its subsidiary companies as such from the provisions of the 1935 Act, other than Section 9(a)(2) thereof.

Most of the gas distributed by Peoples Gas and North Shore Gas is transported to the utilities' distribution systems by interstate pipelines. The pipelines' services (transportation and storage service) are regulated by the Federal Energy Regulatory Commission (FERC) under the Natural Gas Act and the Natural Gas Policy Act of 1978. (See "Sales and Rates" and "Current Gas Supply".)

Under United States Department of Transportation regulations, the Commission is responsible for monitoring Peoples Gas' and North Shore Gas' safety compliance program for its pipelines under 49 CFR Part 192 (Transportation of Natural and Other Gas by Pipeline: Minimum Federal Safety Standards) and 49 CFR Part 195 (Transportation of Hazardous Liquids by Pipeline).

In November 2002, the United States Congress enacted the Pipeline Safety Improvement Act of 2002, which is expected to be signed into law by the President. The Act makes numerous changes to pipeline safety law, the most significant of which is the requirement that operators of pipeline facilities implement written integrity management programs. Such programs must include a baseline integrity assessment of each of an operator's transmission facilities that must be completed within 10 years after enactment of the legislation. Peoples Gas owns and operates 429 miles of pipelines subject to this requirement and North Shore Gas owns and operates 95 miles of pipelines subject to this requirement. Implementation of this legislation is not expected to have a material adverse effect on the financial condition or operations of Company.

* All volumes of natural gas set forth in this report relating to the Company's gas distribution segment are stated on the billing basis of 1,000 Btu per cubic foot.

(100 cubic feet = 1 therm; 10 therms = 1 Dekatherm - Dth; 1,000 Dekatherms = 1 MDth)

The business of the Company's utility subsidiaries is influenced by seasonal weather conditions because a large element of the subsidiaries' customer load consists of space heating. Therefore, weather-related deliveries can have a significant positive or negative impact on net income. (For discussion of the effect of the seasonal nature of gas revenues on cash flow, see MD&A - Liquidity and Capital Resources in Item 7.)

During fiscal 2002, the Gas Distribution segment recorded 60 percent of their revenues from November through March. This revenue included the effect of the Company's weather insurance policy.

The seasonality of revenues causes the timing of collections to be concentrated from January through June. A portion of the winter gas supply needs is typically purchased and stored from April through November . Also, planned maintenance and the capital spending on the gas distribution facilities is concentrated in April through November. Because of these timing differences, the cash flow from customers is likely to be supplemented with temporary increases of short-term commercial paper during the late summer and fall. Short-term debt is then reduced over the January through June period.

The Company and its subsidiaries are subject to federal and state environmental laws. Peoples Gas and North Shore Gas are conducting environmental investigations and remedial work at the sites of former manufactured gas plant operations. (See Note 5A of the Notes to Consolidated Financial Statements.) In 1994, North Shore Gas received a demand for payment of environmental response costs at a former mineral processing site in Denver, Colorado. North Shore Gas does not believe that it has liability for the response costs, but cannot determine the matter with certainty. (See Note 5B of the Notes to Consolidated Financial Statements.)

The Power Generation segment, through Peoples Energy Resources, is engaged in the development, construction, operation and ownership of electric generation facilities for sales to electric utilities and marketers. Currently, the Company has an ownership interest in two electric generation facilities. The Company and Dominion Energy, Inc. (Dominion) are equal investors in Elwood Energy L.L.C. (Elwood), which owns and operates a 1,400-megawatt peaking facility near Chicago, Illinois. The plant capacity has been sold through long-term contracts with Exelon Generation Company, LLC (Exelon), Engage Energy America LLC (Engage) and Aquila, Inc., (Aquila). Due to the structure of these contracts and the fact that Elwood is a peaking facility, the majority of Elwood's revenues and the Company's equity earnings in this investment are recognized in the Company's third and fourth fiscal quarters. Peoples Energy Resources is also a 30 percent owner of Southeast Chicago Energy Project, LLC (SCEP), a 350-meg awatt peaking facility on Chicago's southeast side. Power generated by SCEP is sold through a long-term contract with Exelon and revenue is recognized evenly throughout the year.

Peoples Energy Resources is also involved in developing two greenfield power generation projects in the western United States. The two projects, which are in the early stages of development, are located in New Mexico and Oregon. The proposed project in New Mexico is a 280-megawatt gas-fired peaking facility. The proposed Oregon project is a 1,150-megawatt gas-fired combined cycle facility located near Klamath Falls, Oregon, near the California-Oregon Border trading hub.

The investments in the New Mexico and Oregon facilities have been limited to permitting work and buying land and water options. No major equipment will be ordered or purchased until Peoples Energy Resources has a high degree of confidence that a long-term offtake agreement with a creditworthy customer is feasible.

Peoples Energy Resources continues to evaluate opportunities to acquire power generation assets in the Midwest region that would be a strategic addition to its portfolio.

Under the 1935 Act, an exempt wholesale generator (EWG) is exempt from being deemed a public utility for purposes of the 1935 Act and no company will become a holding company under the 1935 Act as a result of owning an interest in an EWG. To qualify as an EWG, an entity must be engaged exclusively in the business of owning or operating an eligible facility and selling electricity at wholesale. An eligible facility is a generating facility used solely to produce electricity exclusively for sale at wholesale. Elwood was first certified as an EWG by FERC in 1999 and SCEP was first certified as an EWG by FERC in 2002.

Air quality regulations of the United States Environmental Protection Agency (EPA) and the Illinois Environmental Protection Agency (IEPA) in accordance with the federal Clean Air Act and the Clean Air Act Amendments of 1990 require permits to construct and operate certain emission sources and impose restrictions on the emission of certain pollutants, including sulfur dioxide and nitrogen oxide. Elwood and SCEP are currently in compliance with these permitting requirements.

The 1990 Amendments require the reduction of sulfur dioxide emissions from electric generating utilities to reduce acid rain. Elwood and SCEP comply with the sulfur dioxide emission limitations by purchasing sulfur dioxide allowances. Illinois has adopted regulations requiring reductions in nitrogen oxide emissions to begin in 2004. Elwood and SCEP will comply with these reductions by purchasing any necessary nitrogen oxide emission allowances from the allowance market.

Now pending in the United States Congress are "multi-pollutant" legislative proposals that would require additional reductions in emissions of nitrogen oxide, sulfur dioxide and mercury. Some of these proposals also include reductions in carbon dioxide and other so-called "greenhouse gases." Management is unable at this time to evaluate which proposals may take effect and the impact, if any, of such legislation.

Illinois has enacted "multi-pollutant" legislation that establishes a rulemaking process that could lead to emission reduction requirements for nitrogen oxide, sulfur dioxide and mercury from certain electric generating units such as Elwood and SCEP and authorizes IEPA to establish a voluntary program for reducing greenhouse gas emissions. IEPA has not promulgated regulations implementing this legislation. Accordingly, management is not able to evaluate the impact, if any, of the legislation.

Both Elwood and SCEP are public utilities under the Federal Power Act and subject to the jurisdiction of FERC with respect to wholesale electric rates and other matters. Elwood has received authority from FERC to make wholesale sales of electricity at market-based rates. The FERC's order, as is customary with market-based rate schedules, reserves the right to revoke Elwood's market-based rate authority if it is subsequently determined that Elwood or its affiliates possess excessive market power.

SCEP filed with FERC on June 5, 2002, a cost-based rate wholesale power sales agreement with Exelon in FERC Docket No. ER02-2017-000. FERC accepted the agreement for filing on August 12, 2002.

Peoples Energy Resources manages the Midstream Services segment which is engaged in wholesale activities that provide services to marketers, utilities, pipelines and gas-fired power generation facilities. This segment is focused on the Midwest by providing value added asset-based supply and services and is capitalizing on the reliability of hard assets and the strength of the Company's balance sheet to assure performance.

Peoples Energy Resources also owns a natural gas liquids peaking facility and has several contractual assets of pipeline transportation into the midwest region which enables it to engage in other asset-based wholesale activities.

Peoples Gas owns and operates a natural gas hub. Hub growth is occurring through physical enhancements such as pipeline interconnections and new and innovative hub services. Hub activity is recorded as part of Midstream Services' results due to the nature of its service to wholesalers.

Peoples Energy Resources and Enron Midwest LLC, a subsidiary of Enron were equal partners in enovate L.L.C. (enovate), which engaged in a comprehensive wholesale business for the Chicago marketplace including marketing and trading. Enron filed for protection from creditors under Chapter 11 of the United States Bankruptcy Code on December 2, 2001. Subsequently, the Company acquired Enron Midwest's 50 percent interest in enovate and ceased operations under this entity. (See MD&A - Other Matters - Enron Bankruptcy Filing.)

All remaining physical and contractual obligations of enovate have been transferred to Peoples Energy Resources and the Company continues to fulfill these obligations. Peoples Energy Resources is currently operating its wholesale business.

Currently, Peoples Energy Resources' ongoing business is to focus on asset-based marketing of natural gas with financial trading used to optimize physical asset positions.

Like many nonpipeline sellers, Peoples Energy Resources is authorized by the FERC to sell gas for resale at negotiated rates. The FERC conferred this authority in a rulemaking (Order 547), and Peoples Energy Resources did not need to seek specific approval to make sales for resale at negotiated rates. The FERC does not regulate the sales rates, nor are there any reporting requirements associated with these sales.

Peoples Energy Services primarily manages the Retail Energy Services segment. The three-year data for this segment is not indicative of current or future operations because of the start-up nature of the businesses. The segment continuously showed improvement over the last three years with fiscal year 2002 being the first year showing a profit. Moderate growth is expected for future operations.

The Retail Energy Services segment provides gas, electricity and energy management services, including energy alternatives, to industrial, commercial and residential customers regionally within Illinois. Residential customer choice became available in Illinois during the period of March through May 2002, for both gas and electricity services. Results from two subsidiaries of Peoples Energy Ventures are also included in this segment but are not significant contributors to the segment results.

The Retail Energy Services segment's operating income can be influenced by seasonal weather conditions. Although margins per unit do not vary materially month-to-month, total margin can be impacted by usage. In addition, revenue sensitive items such as customer accounts receivable balances are typically impacted when natural gas or electric prices increase as certain products of the segment are tied to an index. However, some risk to accounts receivables and reserves for uncollectible accounts is mitigated because of fixed price products. The quarterly results of operations and balances should not be considered indicative of the year as a whole.

Peoples Energy Services is one of the largest nonutility energy marketers in the northern Illinois retail energy marketplace. Currently, large competitors are not entering the Northern Illinois service area and smaller marketers may be forced out due to Commission certification requirements. At September 30, 2002 there were 14 competitors in the commercial and industrial segment and five competitors in the residential segment. The competitive landscape has continued to change in the past year as major competitors focused on maintaining market share rather than aggressive growth.

The Oil and Gas Production segment, through Peoples Energy Production, is active in the acquisition, development and production of oil and gas reserves in selected onshore basins in North America. Business is pursued through direct ownership interests in oil, gas and mineral leases. Peoples Energy Production also has a 30 percent equity investment in EnerVest Energy, L.P. (EnerVest), which develops and manages a portfolio of oil and gas producing properties. Peoples Energy Production's primary focus is on natural gas, with growth coming from low-to-moderate-risk drilling opportunities and acquisition of proved reserves with upside potential, which can be realized through drilling, production enhancements and reservoir optimization programs. Certain producing properties owned by Peoples Energy Production qualify for income tax credits as defined in Section 29 of the Internal Revenue Code of 1986. The Section 29 income tax credits are computed based on units of production, and recorded to income as earned. These credits are scheduled to expire December 31, 2002.

Competition in acquiring oil and gas leases and producing properties in the Company's targeted onshore basins is substantial. Competitors include the major oil companies, as well as many independents, some of which have significantly greater resources. In order to grow the current asset base, replace and expand reserves, and increase operating income, the Company must select and acquire from third parties, quality producing properties and prospects for future drilling. The Company has no control over the timing of when these opportunities may become available. When available, the Company believes that it has the ability to evaluate opportunities quickly and to acquire properties without a financing contingency, which may give it a competitive advantage.

Extensive federal, state and local laws govern oil and natural gas operations, regulate the discharge of materials into the environment or otherwise relate to the protection of the environment. Numerous governmental departments issue rules and regulations to implement and enforce such laws that are often difficult and costly to comply with and which carry substantial administrative, civil and even criminal penalties for failure to comply. The regulatory burden on the oil and natural gas industry increases its cost of doing business and consequently affects its profitability. The costs of such compliance have not been material to Peoples Energy Production to date. These laws, rules and regulations affect the Company's operations, as well as the oil and gas exploration and production industry in general. The Company believes that it is in substantial compliance with current applicable environmental laws, rules and regulations and that continued compliance with existing requirements will not have a mater ial adverse impact on the Oil and Gas Production segment.

Peoples District Energy is involved in district heating and cooling as a partner in Trigen-Peoples District Energy Company (Trigen-Peoples). This and certain business development activities do not fall under the above segments and are reported in the Other segment. Also included are results from Peoples NGV which has developed fueling stations for natural gas vehicles. Peoples NGV has exited a partnership relating to this business, but continues to operate company-owned refueling stations. No growth from this business is anticipated.

Corporate activities that support the business segments, as well as consolidating adjustments, are included in Corporate and Adjustments.

All of the principal plants and properties of Peoples Gas and North Shore Gas have been maintained in the ordinary course of business and are believed to be in satisfactory operating condition. The distribution facilities serve the City and other areas in northeastern Illinois. Peoples Gas owns and operates an underground gas storage reservoir and a liquefied natural gas plant at Manlove Field located in central Illinois. Peoples Gas also owns a natural gas pipeline that connects Manlove Field and six major interstate pipelines to and from Chicago. The underground storage reservoir also serves North Shore Gas under a contractual arrangement. General properties include a substantial investment in office and service buildings, garages, repair shops and motor vehicles, together with the equipment, tools and fixtures necessary to conduct utility business. Peoples Gas' main office facility is leased.

Most of the principal plants and properties of Peoples Gas and North Shore Gas, other than mains, services, meters, regulators and cushion gas in underground storage, are located on property owned in fee. Substantially all gas mains are located under public streets, alleys and highways, or under property owned by others under grants of easements. Meters and house regulators in use and a portion of services are located on premises being served. Certain storage wells and other facilities of the Manlove Field storage reservoir and certain portions of the transmission system are located on land held pursuant to leases, easements or permits.

Substantially all of the physical properties now owned or hereafter acquired by Peoples Gas or North Shore Gas are subject to (a) the first-mortgage lien of each utility's respective mortgage to U.S. Bank Trust National Association, as Trustee, to secure each utility's respective outstanding first mortgage bonds and (b) in certain cases, other exceptions and defects that do not interfere with the use of the property.

Substantially all of the real and personal property of Elwood is subject to the first mortgage lien of the Indenture to Bank One National Association, as Trustee, to secure Elwood's senior secured bonds. The real and personal property of SCEP is not subject to any liens.

Peoples Energy Resources also is involved in developing two power projects in the western United States. At this time, Peoples Energy Resources holds options to purchase land in New Mexico and Oregon where the facilities may be located.

Peoples Energy Resources' headquarters are located in leased office space in Chicago

Peoples Gas owns and operates a natural gas hub in the Chicago area. Peoples Energy Resources owns and operates a natural gas liquids peaking facility and approximately 44 miles of six inch and eight inch pipeline which is used to buy and sell refinery fuel gas within the Chicago marketplace.

The Retail Energy Services segment does not own material tangible properties. Its primary assets are its customer service contracts and accounts. It's headquarters are located in leased office space in Chicago.

Peoples Energy Production owns working interests in numerous oil and gas leases located in various areas of Texas, Louisiana, New Mexico, Arkansas, Oklahoma and North Dakota. The Company operates a number of the Texas and Louisiana properties. The Company's major operated properties are the Alvarado and North La Reforma fields located in Starr and Hidalgo Counties, Texas, and a portion of the East White Point field located in San Patricio County, Texas (East White Point). As of September 30, 2002, the Company operated approximately 48 percent of it's proved reserves. (See Note 18 of the Notes to Consolidated Financial Statements.)

Peoples Energy Production leases office space in Houston, Texas.

Trigen-Peoples owns a district heating and cooling facility near downtown Chicago. Substantially all of the real and personal property of Trigen-Peoples is subject to a security interest granted to The Prudential Insurance Company of America (Prudential), its successors and assigns with respect to Trigen-Peoples senior term notes, which is nonrecourse debt to the Company. Prudential holds a security interest in the shares of Peoples District Energy owned by the Company in connection with the Trigen-Peoples nonrecourse financing.

Peoples Energy does not own material tangible properties except through its subsidiaries. Its primary assets are its investment holdings in its subsidiaries. The Company leases office space in Chicago from Peoples Gas.

See Note 5 of the Notes to Consolidated Financial Statements.

The Company is involved in various other claims and legal actions arising out of the normal course of business. The Company does not expect that the outcome of these proceedings will have a material adverse effect on the Company's financial position or results of operations.

None.

The following is a list of the names, ages and positions of the executive officers of the Company. Executive officers were elected to serve for a term of one year or until their successors are duly elected and qualified.

The common stock of the Company is listed on the New York Stock, Chicago Stock and Pacific Stock Exchanges (trading symbol: PGL). At November 30, 2002, there were 21,550 registered shareholders.

The common stock price range and dividends declared per common share by quarters for fiscal 2002 and 2001 were as follows:

Results for fiscal 2002 reflect a special charge to increase the reserve for uncollectible accounts, as described below. Results for fiscal years 2001 and 2000 reflect the restatement for the impact of the change in the accounting method for oil and gas properties from the full cost method to the successful efforts method (see Note 1H of the Notes to Consolidated Financial Statements). The previous periods also reflect the impact of other special items described below.

Fiscal 2002 net income decreased to $89.1 million, or $2.51 per share, compared to $96.9 million, or $2.74 per share, in the fiscal 2001 period. Before the impact of the special items in fiscal years 2002 and 2001, net income for fiscal 2002 decreased to $99.3 million, or $2.80 per share, compared to $111.6 million, or $3.15 per share, in the previous period. The decrease in fiscal year results was largely due to the negative impact of weather that was 16 percent warmer than fiscal 2001 and lower pension credits (a noncash item) and equity investment income, which together more than offset the benefits of lower operating costs in the Gas Distribution segment and lower interest expense. The Company's weather insurance policy offset approximately 25 percent of the negative impact of weather.

Fiscal 2001 net income increased to $96.9 million, or $2.74 per share, compared to $82.9 million, or $2.34 per share, in fiscal 2000. Before the impact of the special items in fiscal years 2001 and 2000, net income for fiscal 2001 increased to $111.6 million, or $3.15 per share, compared to $92.7 million, or $2.62 per share, in the previous period. The increase was mainly a result of increased earnings from the Gas Distribution segment, which benefited from colder weather, reduced depreciation expense and from an increase in pension credits. Partially offsetting these effects was an increase in the utilities' provision for uncollectible accounts due to unusually cold weather and higher natural gas prices. Also having a positive effect on fiscal 2001 earnings was continued growth from the diversified energy businesses and an increase in miscellaneous interest income, partially offset by an increase in interest expense.

During the third quarter of fiscal 2002, Peoples Gas recorded a special charge of $17.0 million, or $.29 per share, to increase the reserve for utility uncollectible accounts. Despite an aggressive collection program, receipts from customers with balances over 150 days past due had not improved as much as anticipated. The additional charge will not materially affect the Company's liquidity. The reserve for uncollectible accounts remains an estimate and additional adjustments may be required depending on the level of success of ongoing credit and collection activities. (See Note 7 of the Notes to Consolidated Financial Statements.)

During the fourth quarter of fiscal 2001, Peoples Gas adjusted its reserve for uncollectible accounts by recording a special charge of $8.5 million, or $.14 per share, to reflect collection experience at that time related to the extremely high gas costs associated with the winter of 2000/2001.

In August 2001, Peoples Gas and North Shore Gas announced a special retirement program, which was offered to nonunion employees. Of the 170 employees eligible to retire, 131 employees accepted the offer. As a result, a one-time charge of $26.1 million, or $.45 per share, was recorded to reflect the additional pension expense impact of these early retirements. This adjustment primarily affected the Gas Distribution segment with approximately $1.0 million reflected as corporate activity. This charge reflected the cost of enhancing the benefits for the retirees. Benefits were paid from the pension trust assets and therefore had no impact on operating cash flow. (See Note 9 of the Notes to Consolidated Financial Statements.)

During the fourth quarter of fiscal 2000, the Company recorded $16.1 million, or $0.27 per share, in the Gas Distribution segment in total anticipated costs for the mercury inspection and remediation program. This program was completed in the fourth quarter of fiscal 2001 and the remaining reserve of $10.3 million ($.18 per share) was reversed.

The total impact on earnings of these special items is shown in the following table:

The following tables summarize net income variances before and including special items:

Notes:

1. See Management's Discussion and Analysis of Results of Operations and Financial Condition - Summary Section, for a discussion of the special items.
2. Comparisons between periods are calculated before special items.

The Company's core business is the distribution of natural gas. Peoples Gas and North Shore Gas purchase, store, distribute, sell and transport natural gas to approximately one million customers through a 6,000-mile distribution system serving the City of Chicago and 54 communities in northeastern Illinois. The customer base includes residential, commercial and industrial retail sales and transportation accounts, and provides a broad foundation with no reliance on any particular group of customers. The Company also owns a storage facility in central Illinois and a pipeline that connects the storage facility and six major interstate pipelines to Chicago.

Revenues of Peoples Gas and North Shore Gas are affected by changes in the unit cost of the utilities' gas purchases and do not include the cost of gas supplies for customers who purchase gas directly from producers and marketers. In a normal gas price environment, the unit cost of gas does not have a significant direct effect on operating income because the utilities' tariffs provide for dollar-for-dollar recovery of gas costs. (See Note 1L of the Notes to Consolidated Financial Statements.) However, significant changes in gas costs can materially affect the reserve for uncollectible accounts and working capital needs.

The following table sets forth net margin and degree day statistics for the Gas Distribution segment.

Gas Distribution segment variations are primarily the result of Peoples Gas and North Shore Gas activity. Operating revenues also include the impact of the Company's weather insurance policy ($8.7 million), which is recorded by Peoples Energy directly.

The comparisons below are before the impact of the special items for all periods.

In 2002, revenues for Peoples Gas decreased $661.2 million compared to 2001 due mainly to weather that was 16 percent warmer than the previous period and the lower unit cost of gas. Operating income decreased $25.8 million as a result of lower gas delivery volumes resulting from the effect of the warmer weather and from lower pension credits ($19.1 million). Partially offsetting these effects was a reduction in the ongoing provision for uncollectible accounts ($13.3 million) associated with significantly lower current period revenues.

In 2001, revenues for Peoples Gas increased $614.8 million compared to 2000 due mainly to the higher unit cost of gas ($516.0 million) and higher gas deliveries resulting from weather that was 19 percent colder than the prior period offset, in part, by customer conservation due to the higher gas costs. Operating income increased $30.8 million to $178.7 million due primarily to the effects of colder weather and reductions in depreciation expense ($14.1 million) resulting from revised depreciation rates. Also having a positive impact on operating income were lower outside services expense ($5.4 million) as well as from an increase in pension credits ($6.0 million). Partially offsetting these positive results was an increase in the provision for uncollectible accounts ($11.4 million).

In 2002, revenues for North Shore Gas decreased $117.8 million compared to 2001 due primarily to weather that was 16 percent warmer than the previous period and the lower unit cost of gas. Operating income decreased $2.5 million as a result of lower gas delivery volumes resulting from the affects of warmer weather and from lower pension credits ($1.9 million).

In 2001, revenues for North Shore Gas increased $117.1 million compared to 2000 due mainly to the higher unit cost of gas ($101.4 million) and higher gas delivery volumes due to weather that was 19 percent colder than the prior year, partially offset by customer conservation resulting from higher gas costs. Operating income increased $4.0 million to $26.7 million due mainly to the weather effect. Also affecting operating income was a reduction in depreciation expense ($2.3 million) resulting from revised depreciation rates, partially offset by an increase in the provision for uncollectible accounts ($0.6 million).

The Power Generation segment, through Peoples Energy Resources, is engaged in the development, construction, operation and ownership of electric generation facilities for sales to electric utilities and marketers. Currently, the Company has an ownership interest in two electric generation facilities. The Company and Dominion Energy, Inc. (Dominion) are equal investors in Elwood, which owns and operates a 1,400-megawatt peaking facility near the City of Chicago. Power generated by Elwood is sold through long-term contracts with Exelon, Engage and Aquila. The Company has also made an investment in SCEP, a partnership with Exelon. The Company has a 30 percent interest in SCEP, which owns and operates a 350-megawatt facility. Commercial operations began in July 2002.

Revenue recognition for the Elwood facility is based on contract provisions which assign higher value to summer capacity. The majority of Elwood's annual capacity revenues are recognized in the June to September period, resulting in operating losses in the first and second quarters. Revenue recognition by SCEP is on a straight-line basis based on contract provisions.

Elwood closed a $402 million nonrecourse bond financing on October 23, 2001. (See Note 16 of the Notes to Consolidated Financial Statements.)

In 2002, operating and equity investment income decreased $9.8 million mainly due to the inclusion in this year's results of interest expense associated with Elwood's bond financing. In the prior year, the interim financing costs for this project were reflected as corporate interest expense. The inclusion of this cost significantly reduced equity investment income from Elwood by $16.5 million. Last year's results also benefited from a gain on the liquidation of financial hedges associated with Elwood's gas supply requirements ($4.0 million). Adjusting for the financing and hedge impacts, operating and equity investment income increased significantly due to Elwood's first full year of operation with its expanded facilities, which became commercially operable in June 2001 ($5.9 million), and from the site-development income and start up of operations at SCEP, which began commercial operations in July 2002 ($5.6 million). These benefits were somewhat offset by higher development expenses related to the p ursuit of new power projects.

In 2001, operating and equity investment income increased $8.5 million to $19.9 million. The increase was due mainly to additional equity investment income resulting from the completion of the 750-megawatt Phase II expansion of Elwood ($5.3 million) and a gain on the liquidation of financial hedges associated with Elwood's gas supply requirements ($4.0 million). Effective March 1, 2001, the power sales contracts on the Phase I Elwood units were restructured to essentially eliminate Elwood's fuel price risk. These effects were partially offset by higher development expenses related to the pursuit of new power projects ($1.1 million).

Moody's Investors Service and Standard & Poor's Ratings Services recently downgraded Aquila's senior unsecured debt rating to below investment grade. As a result of Aquila's credit rating downgrades, Aquila has posted letters of credit equal to six months of capacity payments for the benefit of Elwood. In the event Aquila does not fulfill its payment obligations or terminates its power sales tolling agreements and Elwood cannot make adequate alternate arrangements, Elwood could suffer a revenue shortfall or an increase in its costs that could adversely affect the ability of Elwood to fully perform its obligations under the indenture related to its outstanding bonds. If Elwood is adversely affected by the failure of Aquila to make payments under its power sales agreements, the Company may receive substantially reduced or no investment income from Elwood. At this time, the Company cannot determine whether or to what extent Aquila's failure to pay Elwood would result in a material adverse effect on t he Company. (See Note 4 of the Notes to Consolidated Financial Statements.)

The Midstream Services segment is engaged in wholesale activities that provide services to marketers, utilities, pipelines and gas-fired power generation facilities in the upper Midwest. Peoples Energy, through Peoples Gas, owns and operates a natural gas hub. It also owns and operates, through Peoples Energy Resources, a natural gas liquids peaking facility. Peoples Energy Resources and Enron Midwest were equal partners in enovate, which engaged in a comprehensive wholesale business for the Chicago marketplace. Enron filed for protection from creditors under Chapter 11 of the United States Bankruptcy Code on December 2, 2001. Subsequently, the Company acquired Enron Midwest's 50 percent interest in enovate and discontinued partnership operations. (See Other Matters - Enron Bankruptcy Filing.)

Revenues for fiscal 2002 increased $61.0 million. Revenues for fiscal 2001 compared to fiscal 2000 remained flat. In previous periods, enovate income was reported as equity investment income. From late March 2002 until the dissolution of enovate in September 2002, 100 percent of enovate's sales were recorded in revenues.

In fiscal 2002, operating and equity investment income decreased $5.2 million compared to fiscal 2001, due to a reduction in income from enovate ($8.2 million) which benefited from extraordinary market volatility in 2001 and from a decline in wholesale activities ($2.9 million). Offsetting these effects, in part, was an increase in operating income from hub activity ($5.3 million) which experienced a record year due primarily to strong seasonal pricing differentials.

In fiscal 2001, operating and equity investment income increased $7.6 million to $18.0 million, resulting from equity investment income from enovate ($11.3 million), which benefited from extraordinary price volatility in the natural gas marketplace. Offsetting this effect was a decrease in peaking activities ($1.5 million) and earnings recognized in fiscal 2000 from a pipeline construction project ($2.2 million).

The following table summarizes operating statistics for the Midstream Services segment:

The Retail Energy Services segment provides energy, including energy alternatives, to industrial, commercial and residential customers regionally within Illinois. Residential customer choice for Illinois became available during the period of March through May 2002, for both gas and electricity.

Revenues for fiscal 2002 decreased $88.7 million due to a decline in natural gas commodity prices. Revenues for fiscal 2001 increased $114.3 million due to higher natural gas commodity prices and from increased electricity sales. Margins in the Retail Energy Services segment are dependent on various factors such as the regulatory environment, commodity pricing and competitive factors, making revenue statistics an unreliable indicator of results.

In fiscal 2002, operating income increased $4.5 million resulting from higher margin ($5.1 million), partially offset by a slight increase in operating expenses. Volume was slightly up due to warmer weather and power prices remained constant resulting in increased margin from sales contracts that include a price-swing-risk mitigation factor. Additionally, the prior year included short-term electric margin losses from fixed price sales backed by seasonally priced supply.

Fiscal 2001 operating results reflect an operating loss of $3.0 million, an improvement of $1.2 million over the prior period loss of $4.2 million. The improvement is a result of higher margin ($2.0 million) offset, in part, by higher operating expenses. The year-to-year comparison was negatively affected by a $1.5 million gain on the sale of excess inventory in fiscal 2000.

The following table summarizes operating statistics for Peoples Energy Services, the main contributor to the Retail Energy Services segment:

The Oil and Gas Production segment, through Peoples Energy Production, is active in the acquisition, development and production of oil and gas reserves in selected onshore basins in North America. Business is pursued through direct ownership interests in oil, gas and mineral leases. Peoples Energy Production also has an equity investment in EnerVest ($27.0 million), which develops and manages a portfolio of oil and gas producing properties. Peoples Energy Production's primary focus is on natural gas, with growth coming from low-to-moderate-risk drilling opportunities and acquisition of proved reserves with upside potential, which can be realized through drilling, production enhancements and reservoir optimization programs. Certain producing properties owned by Peoples Energy Production qualify for income tax credits as defined in Section 29 of the Internal Revenue Code of 1986. The Section 29 income tax credits are computed based on units of production and recorded to income as earned. These c redits are scheduled to expire December 31, 2002.

In the first quarter of fiscal 2002, the Company elected to change its method of accounting for oil and gas properties from the full cost method to the successful efforts method. All prior year results have been restated accordingly. (See Note 1H of the Notes to Consolidated Financial Statements.) The pretax income effect in fiscal 2001 and 2000 was a reduction in operating income of $126,000 ($81,000 after tax) and $5.6 million ($3.5 million after tax), respectively. The total effect of the restatement on years prior to fiscal 2000 resulted in a decrease in operating income of $5.4 million ($3.3 million after tax).

In June 2002, the Company acquired an interest and operated position in East White Point. The reserves acquired, 90 percent of which are natural gas, were purchased for approximately $10.3 million and added approximately 1.8 MMcfe per day production at the time of the acquisition.

In 2002, revenues increased $11.7 million due to the impact of new production from reserves acquired in 2001, positive results from drilling programs, the East White Point acquisition in June 2002 and the settlement of hedges associated with Enron. (See Other Matters - Enron Bankruptcy Filing.) Operating and equity investment income decreased $3.0 million due mainly to lower results from the EnerVest partnership ($8.6 million), an equity investment that is in the process of being liquidated. Production for the year increased 21 percent, from 43.9 MMcfe per day to 53.0 MMcfe per day. Higher production was partially offset by a decline in net realized natural gas prices from $3.27 per Mcf in fiscal 2001 to $3.11 in fiscal 2002, excluding the impact of the settlement of hedges associated with Enron. Net income for fiscal 2002 was positively impacted by the utilization of Section 29 income tax credits associated with certain producing properties ($4.5 million).

In 2001, revenues increased $22.8 million to $54.0 million due to the impact of new reserves acquired, positive results from drilling programs and higher sales prices on production volumes. Operating and equity investment income increased $15.7 million to $19.1 million due primarily to higher revenues from production sales and the sale of a developed EnerVest property ($4.7 million). Offsetting these effects, in part, were higher operating expenses ($4.0 million) and increased depletion expense ($7.9 million). Net income for fiscal 2001 was positively impacted by the utilization of Section 29 income tax credits associated with certain producing properties ($4.7 million).

As of September 30, 2002, the Company had hedges in place for 13,832 MMbtus of its expected fiscal 2003 production. These hedges are a combination of swaps and no cost collars. Utilizing the collar floors, the weighted average hedge price for fiscal 2003 for hedges in place at September 30, 2002 was $3.30 per MMbtu. In addition, as of September 30, 2002, the Company had hedges in place for 272,650 Bbls of its expected fiscal 2003 oil production at an average price of $20.82 per Bbl. Natural gas hedges are based on New York Merchantile Exchange's Henry Hub Natural Gas Contract (NYMEX) and oil hedges are based on New York Merchantile Exchange WTI Crude Oil Contracts (WTI).

The Company anticipates quarterly earnings over the next fiscal year to be impacted, either positively or negatively, as EnerVest is exited through the periodic sale of partnership properties. The gains or losses on the sale of these properties will be recognized in the quarter in which they occur. The Company continues to work with EnerVest and the other partners to maximize the value of the partnership.

In November 2002, the Company acquired an interest in five properties in south Texas and the upper Texas gulf area. The reserves acquired, 99 percent of which are natural gas, were purchased for approximately $33.0 million and added approximately 11 MMcfe per day production at the time of the acquisition.

The following table summarizes operating statistics for the Oil and Gas Production segment:

The Company is involved in other activities such as district heating and cooling through its Trigen-Peoples District Energy Company (Trigen-Peoples) partnership and miscellaneous nonmaterial investments. These and certain business development activities do not fall under the above segments and are reported in the Other segment. The reported results also include income from the operation of fueling stations for natural gas vehicles.

Over the fiscal years 2002, 2001 and 2000, operating and equity investment income remained relatively flat.

Corporate activities that support the business segments, as well as consolidating adjustments, are included in Corporate and Adjustments.

In 2002, operating losses in this segment remained relatively flat as compared to 2001. The impact of the lower Peoples Energy stock price on outstanding grants under the Company's equity compensation plans ($4.6 million) was offset by higher corporate support expenses.

In 2001, the $12.8 million increase in operating loss was mainly due to the impact of a higher Peoples Energy stock price on outstanding grants under the Company's equity compensation plans ($5.6 million) and an increase in outside services expenses ($2.1 million).

In 2002, other income decreased $7.5 million due mainly to a reduction in interest income ($10.0 million) and to a lower gain in the current year versus the previous year from the disposition of property ($3.1 million). These negative effects were partially offset by an insurance settlement ($6.2 million).

In 2001, other income increased $15.9 million due mainly to an increase in miscellaneous interest income ($11.0 million) and a $4.8 million gain on the sale of property.

In 2002, other expense decreased $1.9 million resulting from a $3.1 million loss in the prior period due to the write-off of the investment in Whitecap Energy System Partnership (Whitecap), and from a loss in the previous period on the disposition of property ($2.8 million). Partially offsetting these effects was the impact of investment and fixed asset impairment losses ($4.1 million) in fiscal 2002.

In 2001, other expense increased $6.4 million due mainly to a $3.1 million loss due to the write-off of the investment in Whitecap and from a loss on the disposition of property ($2.8 million).

In 2002, other income, net of other expense, for Peoples Gas remained relatively flat. The effect of an insurance settlement ($3.7 million) was almost completely offset by the lower gain in the current year versus the previous year from the disposition of property ($3.1 million).

In 2001, other income, net of other expense, for Peoples Gas increased $4.7 million to $8.4 million due mainly to a $4.8 million gain on the sale of property and to an increase in imputed interest on amounts recoverable from customers ($0.9 million). Partially offsetting these effects was a decrease in the allowance for other funds used during construction ($1.1 million).

In 2002, other income, net of other expense, for North Shore Gas increased $2.3 million due mainly to an insurance settlement ($2.5 million).

In 2001, the North Shore Gas variation for other income net of other expense was insignificant.

In 2002, interest expense decreased $15.6 million from fiscal 2001 due to several factors. Interest decreased due to a reduction in corporate short-term debt ($7.9 million) mainly due to Elwood's bond financing. This impact is partially offset by the full year of interest expense in 2002 associated with the $325 million in corporate notes issued in January 2001 to fund the expansion of the diversified businesses ($6.4 million). Utility short-term borrowing requirements were much lower due to the impacts of warmer weather, lower natural gas prices and improved customer collections ($8.3 million). Additionally, the Company benefited from lower interest rates on commercial paper ($1.0 million) and Peoples Gas' variable rate bonds ($3.7 million).

In 2001, interest expense increased $19.1 million from fiscal 2000 to $72.1 million. Short-term interest expense increased primarily due to increased working capital needs of the utilities ($10.1 million) offset, in part, by a decrease in Peoples Energy's corporate short-term interest expense ($5.3 million) due to a reduction in commercial paper outstanding. Peoples Energy's long-term interest expense increased $20.0 million due to the issuances of long-term debt in July 2000 and January 2001 to fund diversified business expansion. Partially offsetting these effects was a full year impact of lower interest on Peoples Gas' long-term debt due to prior year refinancing ($7.4 million).

In 2001, proceeds from the Company's short-term borrowings were being used to fund diversified business operations prior to arranging permanent financing. Proceeds from Peoples Gas' and North Shore Gas' short-term borrowings were being used to fund seasonal working capital needs.

In 2002, interest expense for Peoples Gas decreased $13.1 million due mainly to lower short-term borrowing requirements ($6.3 million) resulting from warmer weather, lower natural gas prices and improved customer collections. Also impacting interest expense was lower interest rates on Peoples Gas' variable rate bonds ($3.7 million) and other short-term debt ($2.3 million).

In 2001, interest expense for Peoples Gas increased $3.1 million to $36.7 million. Short-term interest expense increased $9.9 million due to increased working capital needs. This was offset, in part, by the full year impact of lower interest on Peoples Gas' long-term debt due to the prior year refinancing ($7.4 million).

In 2002 and 2001, the North Shore Gas variations for interest expense were insignificant.

In preparing the Company's financial statements using generally accepted accounting principles (GAAP), management exercises judgment in the selection and application of accounting principles, including making estimates and assumptions. Management considers its critical accounting policies to be those that are important to the representation of the Company's financial condition and results of operations. They require management's most difficult and subjective or complex judgments, including those that could result in materially different amounts if the Company reported under different conditions or using different assumptions. Management considers its current critical accounting policies to be in the areas of regulated operations, environmental activities relating to former manufactured gas operations, retirement and postretirement benefits, derivative instruments and hedging activities and depreciation, depletion and amortization (see Notes 1K, 5A, 8, 1O and 1I of the Notes to Consolidated Fin ancial Statements). There have been no material changes in the policies that management considers as its critical accounting policies except for the change in accounting for depletion expense from the full cost method to the successful efforts method.

Regulated Operations. Due to the regulation of the Company's utility subsidiaries, certain transactions are recorded based on the accounting prescribed in Statement of Financial Accounting Standards (SFAS) No. 71. Under this statement certain costs or revenues are deferred on the Balance Sheet until recovered or refunded through rates. Although management has no discretion in recording these items, actions of the Commission could have an affect on the amount recovered from or refunded to customers. Any differences between recoverable or refundable amounts and the amounts deferred would be recorded in income at the time of any Commission action. If all or a reportable portion of the utility operations becomes no longer subject to the provision of SFAS No. 71, a write-off of related regulatory assets or liabilities would be required, unless some form of transition cost recovery continued through rates established and collected for the remaining regulated operations. (See Note 1K of the Notes to Conso lidated Financial Statements.)

Environmental Activities Relating to Former Manufactured Gas Operations. The Company's utility subsidiaries, their predecessors and certain former affiliates operated facilities in the past at multiple sites for the purpose of manufacturing gas and storing manufactured gas (manufactured gas sites). The utility subsidiaries are accruing and deferring the costs they incur in connection with environmental activities at the manufactured gas sites pending recovery through rates or from insurance carriers or other entities. The amounts deferred include costs incurred but not yet recovered through rates at the low end of a range of costs that management estimates the utilities will incur in investigating and remediating the manufactured gas sites. Management's estimate is based upon an ongoing review by management and its outside consultants of future investigative and remedial costs.

Management considers this policy critical due to the substantial uncertainty in the estimation of future costs with respect to the amount and timing of costs and the extent of recovery from other potentially responsible parties. (See Note 5A of the Notes to Consolidated Financial Statements.)

Retirement and Postretirement Benefits. The calculation of pension expense (credits) relies on actuarial assumptions including discount rate, long-term rate of return on assets and assumed future increases in compensation. These assumptions are determined annually and changes to the assumptions can have a material effect on the amounts recorded from year-to-year. Additionally, when an employee retires and takes his/her retirement benefit as a lump sum, a settlement amount, under SFAS No. 88 "Employers' Accounting and Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," is calculated representing the difference between the actuarial liability for this employee and the lump sum. The Company has chosen to record this difference as well as a portion of previously unrecognized gains and losses in the current period instead of amortizing the difference over the expected average service life of the remaining participants. Both methods are acceptable under GAAP. Ther efore, the timing of retirements can have an affect on the amount recorded in any given year. (See Note 8 of the Notes to Consolidated Financial Statements.)

In addition, the Company and its subsidiaries currently provide certain health care and life insurance benefits for retired employees. Substantially all employees may become eligible for such benefit coverage if they reach retirement age while working for the Company. The Company accrues the expected costs of such benefits during a portion of the employees' years of service. This accrual is based on assumptions regarding discount rates, rate of return on assets and rate of health care cost inflation.

Derivative Instruments and Hedging Activities. The Company enters into financial derivative contracts to hedge price risk on natural gas purchases and sales. For each contract, management must determine whether the underlying transaction qualifies as a hedge under derivative accounting rules. If contracts do qualify as hedges, they will have minimal effect on income until settled. Otherwise, the change in the fair value of these contracts would be recorded in income monthly and result in potentially significant impacts both positive and negative. Additionally, due to the nature of the Company's businesses, most of the Company's contracts for physical purchases and sales of gas or power meet the definition of a derivative, but are exempt from derivative accounting requirements under the normal purchase and sale exemption. Under this exemption, if the transactions are clearly intended to meet the requirements of the customers, mark-to-market accounting is not required. Management judgment is required to make this determination. (See Note 1O of the Notes to Consolidated Financial Statements.)

Depreciation, Depletion and Amortization. The Company's depreciation expense is a direct result of applying Company asset retirement experience to industry standard property retirement data in calculating property useful lives. In situations where this information is unavailable, engineering estimates or management judgement are used. While the Company believes its method is statistically sound, actual experience may vary from the estimate and could have a significant impact on the Company's depreciation expense. Changes in service lives for the utility subsidiaries require approval of the Commission. The service lives currently used by the utility subsidiaries were approved by the Commission in November 2000.

For the Oil and Gas segment, the Company has chosen between two acceptable methods of accounting, full cost or successful efforts. In the first quarter, the Company changed its accounting method from the full cost method to successful efforts method, the preferred method of the SEC.

The amortization rate under successful efforts is calculated by dividing capitalized costs of proved reserves by the estimated reserves for each pool of property. Management judgment and engineering analysis is required to determine amortization pools and reserve estimates. (See Notes 1H and 1I of the Notes to Consolidated Financial Statements.)

Accounting Standards. In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires an entity to record a liability and corresponding asset representing the present value of legal obligations associated with the retirement of tangible, long-lived assets. SFAS No. 143 is effective for fiscal years beginning after June 2002. The company will adopt the regulation on October 1, 2002 and will not record any significant adjustment. The company's largest asset base is its gas transmission and distribution system. A legal obligation may be construed to exist due to the requirement to cut off the pipes and cap them at final abandonment. However, mass assets such as transmission and distribution assets generally have indeterminate cash flow estimates and no settlement dates. Since that exposure is in perpetuity and can not be measured, under SFAS No. 143 no liability will be recorded. The adoption of SFAS 143 will not result in a cumulative effect adjustmen t or restatement of prior years results.

In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This Statement amends various existing authoritative pronouncements to make technical corrections, clarify meanings or describe their applicability under changed conditions. The standard is effective for fiscal years starting after May 2002. The Company does not expect this standard to have a material effect on its financial conditions or results of operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The standard will be effective for exit or disposal activities initiated after December 2002. The Company does not expect this standard to have a material effect on its financial condition or results of operations.

On October 25, 2002, the FASB through EITF Issue 02-03, "Issues Involved in Accounting for Contracts under EITF 98-10," rescinded EITF 98-10, "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." The rescission will have no effect on the Company. It reaffirmed the Company's accounting practice for certain energy-related contracts and the adoption will not result in cumulative catch-up adjustments or restatement of prior years' financial statements.

Enron Bankruptcy Filing. In April 2002, the United States Bankruptcy Court in New York approved the assignment of Peoples Gas' and North Shore Gas' gas purchase and agency agreements with Enron to Occidental Energy Marketing (Occidental).

In other court-approved transactions, Occidental was also assigned, and in turn settled, certain hedges formerly in place with Enron. These hedge contracts were reflected on the December 31, 2001 financial statements as receivables of $2.5 million for financial hedges based on the price in effect at the time the hedges were declared ineffective. The contracts were settled in the second quarter with Occidental at a market price of $7.6 million resulting in a $5.1 million gain in income. The Company has no additional exposure related to the Enron bankruptcy.

Also during the second fiscal quarter, the Company acquired Enron Midwest's 50 percent interest in enovate, its partnership with Enron Midwest, and is continuing to provide wholesale services to the Chicago regional marketplace independently. Results from this business are recorded in the Midstream Services segment and the Company has ceased operations under the enovate name.

Business Environment. A number of significant matters have caused the investment community to question the valuation of companies in equity and capital markets. These concerns result from irregularities found in financial statements, the bankruptcy of several large corporations, a weak economy, significant drop in value of equity securities, the uncertainty of deregulation in the energy market, continued competitive pressures and the cyclical nature of energy commodity prices. Energy trading companies with substantial market risk have responded by reducing or eliminating trading activity, selling noncore assets, reducing debt and clarifying or restating financial information. Congress has enacted new laws and the SEC has issued new and proposed regulations that have increased disclosure and oversight of markets and companies. (See Risk Management - Credit Risk.)

Competition and Deregulation. As of May 2002, all retail gas customers, including residential customers, in northern Illinois (in the service territories of the Company's Gas Distribution subsidiaries and Nicor Gas) have the opportunity to select an alternative supplier other than the local utility (an alternative gas supplier). Outside of these three service territories, only large-volume customers have the ability to choose an alternative gas supplier. Because the Gas Distribution utilities do not make any profit on the commodity cost of gas and because transportation charges are basically the same for customers using an alternative gas supplier and for sales customers, the operating income of the Gas Distribution utilities is generally not affected by whether a customer is a transportation customer or a sales customer.

With respect to retail electric competition, the phase-in of open access set forth in the December 16, 1997 electric restructuring law is now complete. As of May 1, 2002, all retail electric customers, including residential customers, have the ability to select an alternative retail electric supplier, which is a nonutility supplier or an electric utility other than the customer's local electric utility. However, as of October 31, 2002, no company has requested the required authorization from the Commission to provide electricity service to residential customers. Customers who buy their electricity from an alternative retail electric supplier are required to pay transition charges to the utility through the year 2006. Management believes that the restructuring of the electric market in Illinois under this legislation will not have a material adverse effect on the competitive position of the Company's subsidiaries.

Change in Independent Public Accountants. Effective June 1, 2002, the Company terminated the services of Arthur Andersen LLP as the Company's independent public accountants and engaged Deloitte & Touche LLP to serve as the Company's independent public accountants for 2002. (See Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.)

The following is a summary of cash flows for the Company for the fiscal years ended September 30:

The primary increase in cash from operations in fiscal 2002 over 2001 is due to improvement in collections of past due amounts from customers and the collection of a miscellaneous receivable. The net cash used in investing activities decreased due to the collection of advances to Elwood due to project financing of that facility. The decrease in net cash provided by financing activities is due to a reduction in short-term debt and the issuance of $325 million of long-term debt in 2001 and none in 2002.

The following is a summary of cash flows for Peoples Gas, for the fiscal years ended September 30:

The following is a summary of cash flows for North Shore Gas, for the fiscal years ended September 30:

See the Consolidated Statements of Cash Flows and the discussion of major Balance Sheet Variations for more detail.

The Company's total assets at September 30, 2002 decreased $252.5 million compared to September 30, 2001.

As a result of permanent financing, Elwood repaid advances from Peoples Energy, including related interest, and returned a portion of partnership equity. As a result, advances to joint venture partnerships were reduced by $147.6 million. Investment in equity investees was reduced by $59.0 million due to the financing and normal partnership distributions. The reduction in investment in equity investees was partially offset by a new investment in SCEP, a partnership with Exelon.

The balance of the reduction in total assets was primarily due to a reduction in cash used to pay down short-term debt and a reduction in customer accounts receivable of $110.4 million due to improvement in collections of past due amounts from Gas Distribution customers. Additionally, miscellaneous receivables related to a prior year storage deal and asset sales were collected. Deferred charges include approximately $4.0 million of costs relating to developing future power production.

Current regulatory liabilities primarily reflect the result of the Gas Distribution segment entering into derivative contracts to protect the price of expected natural gas purchases. The current mark-to-market value of the contracts is recorded in other receivables with a contra entry to current regulatory liabilities.

During fiscal 2002, Peoples Gas and North Shore Gas increased their accruals for environmental liabilities associated with former manufactured gas operations by a total of $56.1 million. This resulted in related increases in regulatory assets, as these costs will be recovered as incurred under rate mechanisms approved by the Commission.

The increase in the debit balance in Accumulated Other Comprehensive Income (AOCI) is due to deferred losses from cash flow hedges resulting from higher commodity prices, partially offset by decreases in the Company's minimum pension liability. The change in deferred losses from the cash flow hedges is offset by the gains in the forecasted transactions being hedged.

The change in the net of gas costs recoverable and gas costs refundable is a short-term timing difference between cost of gas delivered by Peoples Gas and North Shore Gas and the gas costs billed to customers.

Total assets for Peoples Gas at September 30, 2002 decreased $70.3 million compared to September 30, 2001. Accounts receivable declined $99.9 million due to improvement in collections from customers of past due amounts from customers. Additionally, miscellaneous receivables related to a prior year storage deal and asset sales were collected. Current regulatory liabilities of Peoples Gas primarily reflect the result of derivative contracts entered into to protect the price of expected natural gas purchases. The current mark-to-market value of the contracts are recorded in other receivables and intercompany receivables with a contra entry to current regulatory liabilities. During fiscal 2002, Peoples Gas increased its accrual for environmental liabilities associated with former manufactured gas operations by $49.2 million. This resulted in a related increase in regulatory assets. The change in the net of gas costs recoverable and gas costs refundable is a short-term timing difference between cost of gas delivered by Peoples Gas and the gas costs billed to customers.

Total assets for North Shore Gas at September 30, 2002 increased $7.1 million compared to September 30, 2001. Current regulatory liabilities of North Shore Gas primarily reflect the result of derivative contracts entered into to protect the price of expected natural gas purchases. During fiscal 2002, North Shore Gas increased its accrual for environmental liabilities associated with former manufactured gas operations by $6.9 million. This resulted in a related increase in regulatory assets. The change in the net of gas costs recoverable and gas costs refundable is a short-term timing difference between cost of gas delivered by North Shore Gas and the gas costs billed to customers.

The Company and its two regulated utilities have access to outside capital markets, commercial paper markets and internal sources of funds that together provide sufficient resources to meet cash requirements. The Company does not anticipate any changes that would materially alter its current liquidity position.

Due to the seasonal nature of gas usage, a major portion of the utilities' cash collections occurs between January and June. Because of timing differences in the receipt and disbursement of cash and the level of construction requirements, the utility subsidiaries borrow from time-to-time on a short-term basis. Short-term borrowings are repaid with cash from operations, other short-term borrowings or refinanced on a permanent basis with debt or equity, depending on market conditions and capital structure considerations.

In addition to cash generated internally by operations, as of September 30, 2002, the Company had credit facilities of $257.7 million which primarily support its commercial paper borrowing, of which $254.5 million was uncommitted. The Company's credit facilities provide that the lenders under such facilities may terminate the credit commitments and declare any outstanding amounts due and payable if the Company's debt-to-total capital ratio exceeds 65 percent during any period of time that the Company's senior unsecured debt rating falls below A- (Standard & Poor's) or A3 (Moody's Investor Services). Also, Peoples Gas has $117.3 million of credit facilities of which up to $24.0 million is also available to North Shore Gas. As of September 30, 2002, $34.6 million was uncommitted. The credit facilities of the Company as well as those of the utilities are expected to be renewed when they expire, although the exact amount of the renewals will be evaluated at that time and may change.

The Company's current credit ratings were recently downgraded by Moody's Investor Service and Standard & Poor's, and Fitch Ratings lowered its outlook from stable to negative. The Company has been assigned corporate credit ratings of A3 by Moody's, A- by Standard & Poor's and A+ by Fitch Ratings. The commercial paper ratings are P-2, A-2 and F-1, respectively. The senior unsecured debt rating is BBB+ by Standard & Poor's, A3 by Moody's and A+ by Fitch Ratings. Senior secured debt of each utility subsidiary is rated Aa3 by Moody's, A- by Standard & Poor's and AA by Fitch Ratings. The commercial paper of each utility subsidiary is rated P-1 by Moody's, A-2 by Standard & Poor's and F-1+ by Fitch Ratings.

Off-balance sheet debt at September 30, 2002 and September 30, 2001 consists of the Company's pro rata share of nonrecourse debt of various equity investments, including Trigen-Peoples ($15.7 million and $15.8 million), EnerVest ($5.7 million and $19.8 million) and Elwood ($196.9 million and $0). At September 30, 2002 and September 30, 2001, this debt amounted to $218.3 million and $35.6 million, respectively.

The Company has filed a universal shelf registration statement on Form S-3 for the issuance from time-to-time of up to $500 million of securities. At September 30, 2002, no securities have been issued under this registration statement. Proceeds may be used for general corporate purposes, including acquisitions. The Company intends to amend this registration statement to provide the ability to issue up to 1.5 million shares of common stock from time-to-time in one or more negotiated transactions or at the market offerings (as defined in SEC Rule 415 under the Securities Act of 1933) pursuant to a continuous equity offering.

Capital Spending. In fiscal 2002, the Company spent $200.9 million on capital projects and investments in equity investees. The Gas Distribution segment spent $92.7 million on property, plant and equipment of which $81.4 million was spent by Peoples Gas and $11.3 million was spent by North Shore Gas. The remaining $108.2 million was spent by the diversified business segments. The Power Generation segment contributed land and improvements with a market value of $11.0 million plus cash of $43.1 million to the SCEP partnership with Exelon. Cash spent during fiscal 2002 for the land and improvements contributed to SCEP was $1.4 million. This amount plus the cash investment in SCEP is included in capital spending. Additionally, the Power Generation segment spent $12.2 million on other power development projects and Elwood. The Oil and Gas segment spent $45.7 million in developing owned properties and acquiring new properties. Total forecasted capital spending for fiscal 2003 is $204.0 million.

Partnership Advances. During fiscal 2001, the Company increased its advances to joint venture partnerships ($79.2 million) to complete the expansion of the Elwood facility. The funds were repaid early in fiscal 2002 as a result of permanent project financing. (See Note 16 of the Notes to Consolidated Financial Statements.)

Retirement of Debt. In the first quarter of 2002, Peoples Gas retired short-term debt of $200 million that was issued in the first quarter of 2001 using cash on hand, intercompany loans and commercial paper. The Company also retired $100 million in variable rate notes due August 1, 2002.

On December 5, 2002, North Shore Gas redeemed $24.6 million of its First Mortgage Bonds, Series J, using cash on hand, intercompany loans and commercial paper.

Peoples Gas is seeking authority from the Illinois Development Finance Authority (IDFA) to issue $50.0 million of tax-exempt debt to refinance its First and Refunding Mortgage Bonds, Series X, which will result in the redemption of the City of Chicago Gas Supply Revenue Bonds, 1985 Series A (The Peoples Gas Light and Coke Company Project). Peoples Gas is also seeking approval from IDFA to issue approximately $25.0 million to $30.0 million of new tax-exempt debt to finance a portion of 2003 capital expenditures for its gas distribution system.

Working Capital Credit Facility. Elwood, the Company and Dominion have entered into a revolving working capital credit facility under which the Company and Dominion will fund Elwood's working capital requirements up to a maximum aggregate amount of $10.0 million. The facility is dated June 28, 2002 and commenced July 1, 2002. The outstanding loans would earn interest at the A-2/P-2 commercial paper rate plus 50 basis points. At September 30, 2002, the entire amount was available.

Dividends. On February 6, 2002, the Directors of the Company voted to increase the regular quarterly dividend on the Company's common stock to 52 cents per share from the 51 cents per share previously in effect.

Contractual Obligations. The following table summarizes the Company's long-term minimum contractual obligations:

The following table summarizes Peoples Gas' long-term minimum contractual obligations:

The following table summarizes North Shore Gas' long-term minimum contractual obligations:

Guarantees of Unconsolidated Equity Investees and Standby Letters of Credit. As of September 30, 2002, there were $55.4 million of guarantees for debt service and operational guarantees of the Company's unconsolidated equity investments, which is down from $64.4 million at September 30, 2001. Standby letters of credit were $4.7 million compared to $3.2 million at September 30, 2001.

Peoples Gas has one standby letter of credit totaling $2.4 million as of September 30, 2002. North Shore Gas has none.

Environmental Matters. The Company's Gas Distribution utility subsidiaries are conducting environmental investigations and remedial work at certain sites that were the location of former manufactured gas operations. (See Note 5A of the Notes to Consolidated Financial Statements.)

In 1994, North Shore Gas received a demand from a responsible party under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (CERCLA), for environmental costs associated with a former mineral processing site in Denver, Colorado. The demand alleged that North Shore Gas is a successor to the liability of a former entity that allegedly disposed of mineral processing wastes there between 1934 and 1941. (See Note 5B of the Notes to Consolidated Financial Statements.)

Gas Charge Reconciliation Proceeding for Fiscal 2001. The Commission is conducting a proceeding regarding the fiscal 2001 reconciliation of Peoples Gas' revenues from the Gas Charge and related costs. In this proceeding, the Commission Staff (Staff) has raised concerns about gas costs associated with gas that Peoples Gas resold as part of its normal operational practices. The Staff has not yet submitted evidence or made a specific recommendation, but, as part of the discovery process, it filed a motion to compel the production of certain information about these transactions and their possible relationship to Peoples Gas' affiliates. The Commission's Administrative Law Judge has not ruled on the motion, which Peoples Gas is contesting. Peoples Gas submitted additional direct evidence on October 16, 2002. On November 19, 2002, the Administrative Law Judge set a schedule for further proceedings in this matter. An order from the Commission is not expected before the third quarter of calendar 2003. Peop les Gas believes that its gas costs were prudently incurred but cannot predict the outcome of the proceeding. Fiscal year 2002 gas charge reconciliation cases were initiated on November 7, 2002.

Market Risk. The Company's earnings may vary due to changes in commodity prices (market risk) through its subsidiaries' operations and investments. To manage this market risk, the Company uses forward contracts and financial instruments, including commodity futures contracts, swaps, no cost collars and options contracts. These instruments are commonly referred to as derivatives because they derive their values from the price of an underlying physical commodity or security.

It is the policy of the Company to use these instruments solely for the purpose of managing risk and not for any speculative purpose. All market risk is identified and reduced to levels less than the maximum earnings-at-risk limit approved by the Board of Directors. All hedging is conducted on registered exchanges or with counterparties that meet stringent credit requirements. Formal risk management policy and procedures are in place for all subsidiaries. Most of these instruments qualify for hedge accounting. Therefore gains and losses from these instruments will be recorded in the Income Statement in the month that hedged item is purchased or sold. Any hedge ineffectiveness is booked monthly to the Income Statement. (See Note 1O of the Notes to Consolidated Financial Statements.)

The Company monitors and controls its derivative and physical positions using analytical techniques including measuring future obligations to changes in market price (mark-to-market), sensitivity analysis and value at risk. This process provides information on credit exposure as well as the current value of the portfolio. All valuations are based on well publicized market prices rather than model valuation projections. Monthly projections of basis valuation are based on deal quotes and adjusted for seasonality based on historical trends.

Starting in the second quarter of 2002, the Company's utilities began to use financial derivative instruments to lock in the purchase price for a portion of their future natural gas purchases. The strategy is intended to minimize fluctuations in gas costs charged to the utility gas sales customers. Since these derivative instruments are not designated as hedges and are employed to support gas costs charged to utility gas sales customers, the accounting for these derivative instruments is subject to SFAS No. 71. Therefore, changes in the market value of these derivatives are recorded as a regulatory asset or regulatory liability on the Consolidated Balance Sheet. Gains or losses on the settlement of these contracts are included as an adjustment to gas purchases in the determination of the monthly gas charge passed through to customers.

The Company has positions in natural gas transportation and inventory as part of its Midstream Services operations. The Company uses derivative financial instruments to protect against loss of value in its inventory caused by changes in the market place. Changes in the value of the derivatives are recorded in gas costs with a simultaneous entry to gas costs for any change in the fair value of the physical inventory being hedged. Although most of the physical contracts managed by the Midstream Services segment are accounted for on an accrual basis, a number of contracts are recorded on a mark-to-market basis. As of September 30, 2002, the mark-to-market liability and asset of these contracts was immaterial.

The Company has working interests in natural gas and crude oil producing properties. Using swaps, no cost collars and options, the Company had hedges in place as of September 30, 2002 for 13,832 MMbtus of its fiscal 2003 gas production. Utilizing the collar floors, the weighted average hedge price for fiscal 2003 for hedges in place at September 30, 2002, was $3.30 per MMbtu. In addition, as of September 30, 2002, the Company had hedges in place for 272,650 Bbls of its fiscal 2003 oil production at an average price of $20.82 per Bbl. Natural gas and crude oil hedges are based on prices established by the NYMEX.

The Company sells fixed price and variable priced products as part of its Retail Energy Services business. Price risk is managed through the use of supplier contracts, storage and financial transactions. As of September 30, 2002, the exposure from open positions was immaterial.

The Power Generation segment has entered into power sales tolling contracts that effectively eliminate fuel price risk.

The following table presents the valuation of outstanding contracts at September 30, 2002 and 2001:

The maturity of the fair value hedges and the mark-to-market contracts fall within the next 12 months. Included in the value of mark-to-market contracts are amounts relating to the utility subsidiaries gas price protection program ($31.1 million). All gains or losses from these contracts will be included in the gas charge to customers at maturity. The maturities of the cash flow hedges is detailed in the table below. All valuations are based on NYMEX closing prices at September 30, 2002.